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The US and China held the fifth round of the bilateral Strategic and Economic Dialogue talks this week. While there are many issues that were discussed, trade, reportedly, figured prominently. Yet both countries are likely using an antiquated framework.

Specifically, with a new OECD-WTO data base, officials do not have to be satisfied any longer with just looking that the value of goods that cross national frontiers. What is more important, given the increasingly globalized production, is the value-added. Traditional trade figures are based on total value of the goods (services). This made sense when production was generally national and finished goods were exported to meet foreign demand.

We can be more discerning now. Value-added is a key concept to truly understand trade flows. Value-added can be calculated by adjusting the gross value at any stage of the production process for the value of the inputs.

In a recent Economic Letter, the Dallas Fed drew on the new data base to shed fresh light on the US-China trade patterns. In some ways, the research confirms what has long been suspected. China engages in low value-added work at the latter stages of the production process. The US does higher valued added work at earlier stages of the production process. The most recent data for this is 2005. Then the value-added in China's gross output was 34% compared with 53% in the US and the OECD average (excluding the US and China) was 47%.

What is true for overall output is reflected in the composition of trade flows. More than three quarters of China's imports are intermediate goods. About half US imports are intermediate goods and OECD average is near 60%. Final goods account for only a quarter of China's imports and nearly 50% of US imports. This is also evident on the export side of the ledger. Intermediate goods account for about 40% of China's exports compared with 55% in the US. Final goods account for 60% of China's exports and 45% of US exports. The composition of the bilateral trade between the US-China is consistent with these broad themes. Intermediate goods account for 70% of US exports to China,. while 75% of China's exports to the US are final goods.

It is in this context that the OECD/WTO data base on value-added should be understood. On a value-added basis, the trade imbalance between the two largest economies in the world seems considerably smaller than conventional figures, which record the total value of a good at the last stage in the production process. In 2009, the most recent data available, US imports from China were $89 bln small smaller in value-added terms than by the conventional measure. US exports to China for about $26 bln smaller in value-added terms than by the conventional metric.

This means that the value-added trade deficit was $63 bln less than the gross measures. That would reduce the bilateral trade deficit by about a third to $126 bln from $189 bln. That translates into 0.9% of US GDP rather than 1.4% using the conventional measures. Moreover, the Dallas Fed notes that the gap between the conventional and value-added metric is growing as the value-added being done in China has fallen faster than in the US and most other countries.